Borrowing against your life insurance in Canada
Did you know you can borrow against your life insurance? Connect with one of our verified brokers to learn more about your permanent policy options today.
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Jessica Ho
When it comes to borrowing funds, you’re probably familiar with some of the most common methods: mortgages, credit cards, and personal loans. But did you know that it’s also possible to access loans through your life insurance – even while you’re alive?
If you have a permanent life insurance policy, you can borrow against it. Let’s break down what this means and whether it’s the right form of financing for all your needs.
Key takeaways on life insurance borrowing
- You can only borrow from permanent life insurance plans that accumulate cash value (e.g. whole life insurance, universal life insurance). It is not possible to do so with term life insurance.
- While you don’t need to repay a life insurance loan within a specific time frame, the outstanding balance does accrue interest. In certain cases, this can have implications on your policy, such as decreasing your death benefit or causing your coverage to lapse.
- Aside from borrowing against your life insurance, you can also withdraw funds from your cash value reserve. This money does not need to be paid back but doing so will likely decrease the death benefit left for your loved ones.
- Be sure to consult a professional advisor about the best method of financing for your use case – you may find other forms of borrowing (outside of a life insurance policy) to be more applicable (e.g. personal loan).
Can you borrow against your life insurance policy?
Whether you can borrow against your life insurance depends on the type of policy you hold. In most cases, permanent life insurance policies (including whole life insurance and universal life insurance) come with a cash value reserve that builds over time – which is also a fund you can borrow against. Term life plans, on the other hand, don’t come with this option, and therefore, do not have the ability to borrow against.
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Policy type |
Overview |
Ability to borrow |
|---|---|---|
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This policy pays out a set death benefit to your loved ones if you pass away during a set period of time (e.g. 5 to 30 years). It’s ideal if you only need temporary coverage, such as for a mortgage. |
No |
|
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This permanent plan pays out a set death benefit to your loved ones when you eventually pass away, and it comes with a guaranteed cash value reserve that you can access during your lifetime. It’s ideal for those who need lifetime coverage, and it’s best used for final expense coverage, estate planning, and tax liability planning. |
Yes |
|
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This flexible form of permanent life insurance pays out a death benefit to your loved ones when you eventually pass away – both premiums and death benefits can be adjustable within certain limits. You can also choose how you want your cash value reserve to be invested – but the cash is not guaranteed. It’s best for investor-savvy individuals (or those who prefer a more hands-on approach). |
Yes |
It’s important to highlight that permanent life insurance plans are not a right fit for everyone. As the premiums are significantly higher compared to term life plans, the ability to borrow against the policy’s cash value should not be the sole consideration when choosing this type of life insurance for your coverage needs.
How does borrowing against your life insurance work?
As mentioned, borrowing against your life insurance involves taking a loan from the cash value reserve of your policy – here’s a step-by-step look at how it all works.
1. Cash value accumulation – As you pay your premiums, the cash value reserve of your permanent life insurance policy builds over time. Whole life plans typically come with guaranteed returns while others may be variable.
2. Loan request & review – Once you have enough funds in your cash value reserve, you can request to access the funds through a loan. Your insurer will review the request while providing the loan terms (including the interest rate and repayment schedule). Note that taking out a loan via your life insurance often comes with lower interest rates than other traditional methods of borrowing.
3. Receival of funds – If you’re approved for the loan, you’ll receive the funds from your cash value reserve which can then be used for whatever you wish – possible use cases include anything from medical bills and tuition fees to even a family vacation.
4. Repayment plan – The loan is then repaid on top of your regular life insurance premiums. Generally speaking, you won’t be required to repay the funds within a specific time frame, but interest does accrue on the unpaid balance – and if the amount exceeds your cash value, your policy could lapse (causing you to lose all coverage). In this case, you could also then be taxed on the loan you took out. Lastly, any amount and interest owed at the time of your passing will be deducted from the death benefit paid out to your loved ones.
The pros and cons of life insurance borrowing
Life insurance borrowing can be an ideal financing method for certain policyholders, but that isn’t always the case. To gain a better understanding of whether it’s right for you, here are some of the pros and cons.
Pros of life insurance borrowing
No credit check required – Unlike other traditional forms of borrowing, taking a life insurance loan doesn’t come with a credit check, making it a more appealing method if you have a low credit score.
Lower interest rates – Compared to personal loans and credit cards, the interest rate when borrowing against your life insurance policy tends to be much lower (typically 5 to 8%).
Flexible payment plan – Again, you generally aren’t required to pay off the loan within a specific time frame. The cash value reserve is used as collateral which can help cover payments, but be sure you’re aware of any potential implications of leaving an outstanding balance.
Tax advantages – Borrowing against your life insurance can be a smart tax planning move as you generally won’t be taxed on the money taken out as long as your policy stays active.
Cons of life insurance borrowing
Cash value limitations – There are limitations to borrowing through your life insurance as you first need to accumulate enough funds in your cash value – which may even take upwards of 10 years. The amount you’re able to take out is usually also limited to a percentage of your total reserve (such as 90 to 95%).
Death benefit reduction – Again, any unpaid balance along with the accrued interest upon your passing will be deducted from your beneficiaries’ payout. The main use case for life insurance should be protecting your loved ones, so if you have a large outstanding loan, it can impact their financial well-being after your death.
Potential policy lapse – The unpaid loan plus interest (along with any other fees) could cause your policy to lapse if it exceeds your cash value amount. This means all your coverage will be gone, including the death benefit left for your loved ones.
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When you should borrow against your life insurance
There are many reasons you may choose to borrow against your life insurance, such as for emergency medical expenses or business investment opportunities. You may also choose to do so as a means of debt consolidation to pay off another loan, given the lower interest rates of borrowing through a life insurance policy.
But before doing so, be sure to consider other options for accessing the funds in your cash value reserve through your life insurance – this can include withdrawing the money entirely, instead of taking it out as a loan. Life insurance withdrawals don’t need to be paid back, but if the amount taken out of the reserve is more than your premiums paid (also known as the cost basis), it could be subject to taxation. Plus, it typically also decreases your policy death benefit.
You can also consider options outside of your life insurance plan, such as taking out a personal loan or a home equity line of credit. It’s always best to consult with a financial advisor about the best method of accessing funds for your use case.
The bottom line
Borrowing against your insurance policy is one way to access some extra funds during your lifetime, but make sure you understand all the implications of doing so before contacting your insurer. And as always, consult with a financial advisor to ensure this option fits well with your overall financial goals.